Are Bonds Still a Good Idea?

A reader asks if bonds are still a good idea. Consider the risks of investing in a long-term bond portfolio and talk to a financial advisor.

Q: On your radio show, you were discussing the possible problems in the bond market. You stated that in your opinion the bubble would eventually pop. In 2010, when I retired, I attempted to re-balance my portfolio according to the conventional wisdom of investing in more bonds and less stocks as you get older.

All of my investments are inside of regular IRAs or Roth IRAs. Do advise older individuals to get out of bonds, to reduce the percentage of bonds or to stay the course?

A: Conventional wisdom indicates that as you mature you should have more of your portfolio invested in bonds or other fixed-income securities. With interest rates where they are today, you might have to rethink that conventional wisdom.

Say you invested most of your portfolio in bonds yielding about 2 percent. If interest rates rise one or two percentage points, the value of those bonds would decrease by almost half. As interest rates rise, the value of bonds in your portfolio will go down. Some investors forget that there is an inverse relationship between interest rates and the value of bonds.

If you invest $10,000 in bonds that yield 2 percent, you receive income of $200 per year on that investment. But, if interest rates rise to 4 percent, you only need to invest $5,000 to achieve the same $200 yield. For this reason, that bond you had that yielded 2 percent would have a lower value. Most people would not want to buy a bond you own that yields $200 for $10,000 when they could go out in the market and buy a bond for half as much to receive the same yield.

You need to consider that interest rates are at historic lows and while they could still go down, they will probably rise over the next several years. Even a small rise in interest rates can have quite an impact on a bond portfolio. As you decide where to put your money, you need to consider the risk of investing in a long-term bond portfolio.

Now, if you decide to put your money in short-term maturity CDs, you probably have already seen that interest rates on those products are close to nothing. We were talking to a friend who works at the Chicago Board of Trade. His take was that much of the money that should flow into bond products is not, and that money appears to be going to the stock market. He believes that’s why the stock market has returned to the levels it was at prior to the financial problems of 2008. (Hint: It isn’t because the economy is going gangbusters!)

We’d encourage you to talk to a financial advisor about your situation or, at the very least, consider these issues in evaluating how and where to place your money.